Auto-Lease Market May Act as Red Flag
Lingling Wei
Aug 1, 2006
NEW YORK -- Gary Wong has found used SUVs a hard sell.
Higher gas prices have curbed people's appetite for gas-guzzling SUVs in general, says the manager of dealership Platinum Ford in Flushing, N.Y. Even for those still itching to drive big cars, they would rather lease new ones than buy those traded in or coming off leases, thanks to increased leasing promotions and lower maintenance costs of new cars. "I've stopped bidding for midsized and large-sized SUVs at auctions," says the dealer.
A growing number of car shoppers choose to lease rather than buy as rising interest rates have pushed up borrowing costs. But the reluctance by some dealers like Mr. Wong to purchase and resell used automobiles may present some red flags to those who write car leases -- including automakers' own finance units, banks, credit unions and other leasing companies.
Leasing helps sell cars -- luxury brands, bigger vehicles and SUVs in particular -- as leasing customers may opt to keep their cars at the end of their leasing terms or go back to the same dealer to lease a similar car. Leasing can prove profitable to finance companies, too. At the same time, however, potential weaknesses in the demand for off-lease vehicles, as shown by a lack of interest among some dealers to bid at auctions, could also hurt auto financiers' profit opportunities.
Ford Motor Co., for instance, recently noted that a decline in the auction values of SUVs, combined with increased leasing volumes, had contributed to a 15% rise in the depreciation expenses at its financing arm, Ford Motor Credit Co., in the second quarter. The expenses, which totaled $1.26 billion, in turn cut into the unit's profit.
In general, lease underwriters would have to bear losses if the vehicles returned by customers upon lease expiration sold for less than that originally estimated. To account for that "residual value risk," lenders depreciate the vehicles they lease to estimated resale value at the end of their lease terms. The higher the residual assumptions, the lower the charges on leasing customers.
Following the previous leasing boom between 1996 and 1999, lenders collectively suffered about $10 billion in lease-related losses in 2000 simply because they overestimated how much off-lease cars and trucks would be worth, recalls Art Spinella , president of automotive consulting firm CNW Marketing Research in Bandon, Ore.
As a result, many lenders scaled back from the auto-leasing business. Some, including General Electric Co.'s GE Capital and Bank of America Corp., stopped writing auto leases in the U.S. altogether.
This time both car makers and finance companies appear to be treading more carefully, says Standard & Poor's automotive credit analyst Scott Sprinzen : "They are being more conservative with their residual-value assumptions."
J.P. Morgan Chase & Co.'s Chase Auto Finance unit, a leading auto-finance provider independent of car manufacturers, is experiencing gains in the value of off-lease vehicles, says spokeswoman Mary Bean , citing "conservative residual positioning" as well as better-than-expected resale prices of used cars and trucks.
Compared to what is now viewed as overly generous leasing deals back in the late 1990s -- featuring unrealistically high estimates of residual values and thus deflated monthly charges that had enticed car shoppers to lease, auto makers in general are only offering limited-time and limited-scope lease promotions to help sell new models or move slow-selling cars.
For example, through the end of July, a 2006 Toyota Sienna can be leased in the New York region for a downpayment of $1,750 and a monthly tab of $249 for 36 or 48 months. And for auto makers' finance arms and other finance providers, leasing in most cases remains less than one-quarter of their entire portfolios of cars and trucks financed.
"We really learned a hard lesson as an industry," says Kelly Mankin , vice-president of Chrysler brands marketing at Chrysler Financial in Farmington Hills, Mich., a financing unit of DaimlerChrysler AG. "We work closely with the manufacturer" to manage risks including those related to residual values and reselling of off-lease cars, he says. "Let the market determine the leasing mix," he adds.
The current market demand for leasing is primarily driven by higher charges on car loans due to rising interest rates. A customer's monthly lease payment is usually lower than payments for a standard car loan, and that gap only gets bigger when rates are on the rise. Many shoppers for high-priced vehicles, in particular, prefer leasing to buying as they find leasing can give them more bang for the buck. Dan Velez , who manages a Ford dealership in Colonia, N.J., an area where pickups and SUVs populate the road, says leasing has allowed many customers to "free up more money to compensate for fuel costs."
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